What are Stock Market Indices?
A stock market indices shortened as stock market index is an indicator which shows the major change in a particular sector or in the overall market. The stocks which are already listed on the exchange and which can be traded are selected.
These stocks are selected from a specific industry and those companies which fulfills the specific criteria. The criteria of stock selection is based on type of industry, size of the company and its market capitalization.
Each stock market index measures the performance and the price movements of the stocks which creates an index. So, if the price of stocks in an index goes upward, the whole index will rise and if the price of stocks goes down the whole index will fall.
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What are the Types of Stock Market Indices?
There are three type of stock market indices which are are mentioned and described below:
- Benchmark Indices
- Sectoral Indices
- Market- Cap Based Indices
Benchmark Indices
Nifty 50 is an index of National Stock Exchange (NSE) which includes a collection of 50 best performing companies of India. Sensex, is an index of Bombay Stock Exchange (BSE). This type of collection of stocks is known as Benchmark indices since they use the best practices to regulate the companies they pick.
Sectoral Indices
These types of indices are sector focused which means these types of indices only contain one type of stocks such as Nifty Bank which is an indicator to measure the performance of Bank of India, Nifty Bank is a NSE index. Similarly S&P BSE PSU is an index which tells the performance of Public sector banks. Both NSE and BSE have indices to measure the performance of stocks falling in the same sector.
Market-Cap Based Indices
There are few indices which choose stocks based on their market capitalization. Market capitalization refers to the market value of any public traded company in the stock exchange. Indices like S&P BSE and NSE small cap 50 are collections of companies which have lower market capitalization in accordance with the rules set by the Security Exchange Board of India (SEBI).
How are Stock Market Indices Created?
A stock market index is created by putting similar stock based on their market capitalization, industry or by company size. Then, index value is computed based on stock selection.
But it is not that easy. Each stock will come with a different price and the price change in one stock would not be equal to the price range in another stock.
So, the index value cannot be decided based on the simple sum of the prices of all the stocks. So, in order to fix this problem, assigning weight is crucial. Each stock which is a part of an index is assigned a specific weightage based on their market capitalization or by their price lying in the market.
The weight defines the impact in the index caused by the movement of a stock. There are two types of stock market indices which are generally used:
- Market-Cap Weightage
Market capitalization refers to the total market value of a company in the stock exchange. It is calculated by multiplying the total number of outstanding stocks floated by the company and the share price of a stock.
For example- if a stock has a market capitalization of RS. 2,00,000 and the underlying index has a total market capitalization of RS. 10,00,000 then the weightage given to a particular stock will be 20%.
As an investor/trader you need to keep this in mind that weightage keeps on changing daily since the price keeps on changing daily of a stock.
- Price Weightage
In this type of method, the value of an index is determined by the price of a stock not by its market capitalization.
Thus, higher the price of a stock, the higher the weightage of a stock will be in an index.
Conclusion
Stock market indices are highly important for various purposes. Not only it helps investors to make better decisions but also serves as a benchmark for the overall market condition. That’s not all investors and traders have to understand more when it comes to stock market indices and stock market itself.
In this article we understood how Nifty 50 and other indices work but it does not mean that those fifty or those other stocks are good for your investments. Having proper knowledge and right guidance will help you to find your best investments.